DLH Holdings Corp. (DLHC) Q2 2020 Earnings Report, Transcript and Summary

Good day, and welcome to the DLH Holdings Corp. Fiscal 2020 Second Quarter Earnings Call. [Operator Instructions] Please note, today's event is being recorded. I would now like to hand the conference over to Chris Witty, DLH Investor Relations Adviser. Please proceed, sir.

Thank you and good morning, everyone. On the call with me today is Zach Parker, President and Chief Executive Officer; and Kathryn JohnBull, Chief Financial Officer. The company's earnings release and PowerPoint presentation are available on our website under the Investor Relations page. I would now like to provide a brief safe harbor statement, which is also shown on Slide 2 of the presentation. This call may include forward-looking statements that relate to the company's outlook for fiscal 2020 and beyond. These forward-looking statements are subject to various risks and uncertainties that could cause actual results and events to differ materially from these statements. Please refer to the risk factors contained in the company's annual report on Form 10-K and in our other filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. On today's call, we will be referencing both GAAP and non-GAAP financial measures. A reconciliation of our non-GAAP results to our reported GAAP results is included in our earnings release and in the investor presentation on DLH's website. President and CEO, Zach Parker, will speak next; followed by CFO, Kathryn JohnBull. After which, we'll open it up for questions. With that, I'd now like to turn the call over to Zach. Please go ahead, Zach.

Thank you, Chris, and good morning, everyone. Welcome to our second quarter conference call. Of course, the world has changed quite drastically since we began 2020, but DLH has posted solid results in the face of these challenging economic times. If you turn to Slide 3, let me begin by providing a high-level overview of our financial performance and some color around the outlook for the rest of fiscal '20 - '22 - 2020. The company posted revenue of $54.8 million for the quarter, a new record since our restructuring, reflecting the positive contribution of the S3 acquisition as well as our organic growth across the company. While our second quarter is often strong from a top line perspective, this year's performance was helped by an additional demand for mail order prescriptions and other program services, reflecting the current COVID-19 environment. Operating income rose to $3.8 million in the second quarter, and we posted EBITDA of $5.6 million, also a new record. We generated $3.5 million of operating cash in the quarter and, as previously noted, paid down $3 million of our senior debt in January. Kathryn will discuss cash flow and our other debt position more in a moment. I'm also pleased to announce that during the quarter, the Veteran Affairs organization canceled its previously issued request for proposal for the pharmacy services under our CMOP umbrella contract. As you may recall, this RFP included an additional requirement that the prime contractor would be a service-disabled, veteran-owned small business, which would have precluded us from continuing to perform as a prime contractor. After many months of consideration and analysis, the government determined that it would change the requirement and restart the solicitation process at a later date. While we do not yet know exactly how or when the revised procurement process will proceed, DLH does expect its current contracts for these services to be extended. This remains highly valued work to us, and we look forward to participating in the future process. As we adjust to the current economic conditions and the various repercussions from the onset of COVID-19, we are doing everything possible to safeguard the health of our employees and our customers, and our investors can find more information about this topic on our website or in our 8-K filings. I'll also be happy to address any of those specifically during the Q&A session. We see many opportunities to leverage our technology-enabled health care solutions and help bring relief to our country. If you look at Slide 4, we show our portfolio of national, mission-critical operations and the solutions that are well suited to the challenges of our time. Through the various agencies and markets that we serve, we're helping the U.S. attack the COVID-19 challenge and improve the lives of millions. As you can see on the slide, we are involved in a plethora of programs that help care for veterans, communicate health care strategies and emergency information and assess medications as well as potential vaccines. I'm very proud of the work that we are doing in this arena and during - in particular, doing this volatile time in our nation's history. And we're proud of our people for their hard work and their commitment to DLH and the agencies that we serve. Turning to Slide 5. I want to shed some light on a few very specific examples of the work I just mentioned. DLH has many contracts in place across various agencies, including the National Institute of Health, which is primarily to assess potential medications and compile data on drug efficacy. As part of the rapid mobilization to search for potential cures and vaccines related to COVID-19, we have pivoted our infectious disease activities to prioritize this pandemic. I'm sure that many of you have already read about the ongoing clinical trials for remdesivir, hydroxychloroquine and other synthetic medications that are in the news. Leveraging our clinical trials network and our strong in-house team, our preliminary analysis, which is sponsored by the National Institute of Allergy and Infectious Diseases, has shown that remdesivir does accelerate the recovery for patients with advanced COVID-19. We think that this is obviously important work that will really demonstrate our ability to provide these kind of services that would help us in the future. These analyses provide clear evidence that the efficacy of these therapies that may literally mean difference for life or death between millions of Americans will continue to be in our portfolio. While we are not sure how these - how the results of these studies will in the end impact the future of COVID-19, we are clearly in the right place to make a difference for our clients and our nation in future work. In addition, we've seen growing interest across the board for our technology-enabled solutions and well-known expertise in health-driven data analytics. We see incremental growth opportunities at the VA and across HHS, the DHA, Defense Health Agency, CDC and NIH. As seen from our current work on COVID-19, we have long-standing customer relationships with many NIH agencies, again, including the National Institute of Allergy and Infectious Diseases. And we are well positioned to assist Dr. Fauci's organization across an array of initiatives. We're bidding on several contracts that leverage the company's leadership in this arena, including also our telehealth solutions, program management and big data analytics applications, and we expect rapid decision-making on some of these activities that are tied to the pandemic. The need for reliable and accurate research, testing and analysis has never been greater than now. As our government and industry alike race to develop medical treatments and vaccines to battle this urgent public health catastrophe. Now turning to Slide 6, I'd like to remind our shareholders, again, that DLH's InfiniByte Cloud solution is now available on the FedRAMP marketplace, the central portal for the government cloud offerings. FedRAMP, which stands for the Federal Risk and Authorization Management Program, and it - also indicates that federal customers that DLH has undergone a security capabilities assessment and meets the need enhanced by security requirements of the civilian agencies as well as the Department of Defense. We're now able to ensure the confidentiality, integrity and security of the health data in a very fast and reliable manner. InfiniByte Cloud, our secure cloud-based platform, allows us to provide agencies with the data storage and access options that they need in a secure environment to provide the analytical tools to do their work. We believe that this platform-as-a-service marketplace will bolster our new business expansion in the secure data analytics market. Before turning the call over to Kathryn, I just want to wrap up by stating that DLH has proven once again to be a very strong and stable company during these kind of volatile times. We continue to provide mission-critical services to a variety of well-funded government agencies, and the value of our diverse and technology-enabled platforms has never been more clear. This is very consistent with our strategy, and this translates to a steady, somewhat predictable outlook while many in our industry seem to struggle. Again, DLH has strong margins and strong cash flow, and we're strengthening our balance sheet by paying down our senior debt faster than required with no repayments now required until 2022. Our borrowing capacity and tax benefits and low CapEx requirements provide substantial liquidity to sustain the business as we look forward. We take the COVID-19 pandemic very seriously. But also know that our operating model, our program portfolio and industry expertise make us a somewhat unique provider of critical services during these times of need. While safeguarding our employees, we continue to work diligently with many core customers and to get Americans through this tragic turn of events and lead the way to a brighter tomorrow. There is always a way forward, and DLH is proud to improve the lives of these millions of Americans. As FDR said, "The only limit to our realization of tomorrow will be our doubts of today. Let us move forward with a strong and active faith." So be strong and be well. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

Thank you, Zach, and good morning, everyone. Thanks for joining us. We're pleased to report another solid second quarter. Turning to Slide 7. We posted revenue for the 3 months ended March 31, 2020, of $54.8 million versus $33.8 million in the prior year second quarter. The revenue variance reflects the impact of our acquisition of S3 last June, approximately $18.7 million coming from that transaction, as well as strong growth across our other operations. Our second quarter results benefited from higher mail order demand from our VA programs, which more than offset some minor COVID-related reductions for programs requiring travel. Turning to Slide 8. Income from operations rose to $3.8 million for the fiscal 2020 second quarter from $2.3 million last year, reflecting operating margins of 7% and 6.9%, respectively. The greater operating income reflected increased revenue with stronger margins even in the face of higher amortization of acquired intangibles from the S3 transaction. G&A rose to $6.3 million in the second quarter from $4.5 million last year, but declined as a percent of revenue to $11.4 million from $13.3 million in 2019. The decline as a percent of revenue was due to greater operating leverage and the timing of some business development activity. While it's always difficult to pin down the exact time frame, we do expect that business development expenses will be higher in quarters 3 and 4. We reported net income of approximately $2.1 million or $0.16 per diluted share versus $1.3 million or $0.10 a share last year. The company recorded a $0.9 million tax provision this second quarter versus $0.5 million in fiscal '19 with - reflecting higher pretax net income. And interest expense was also $0.9 million in fiscal 2020 versus $0.5 million last year. The year-over-year increase in interest expense was due to higher outstanding debt balances in recognition of the S3 transaction. We continue to pay down debt as expeditiously as possible, as I'll review further in a moment. Turning to Slide 9. EBITDA for the 3 months ended March 31, 2020, was $5.6 million versus $2.9 million in the prior year period, reflecting the S3 acquisition and improved operating leverage. As a percent of sales, EBITDA rose to 10.2% this quarter versus 8.5% last year. A reconciliation of GAAP net income to EBITDA is in our earnings statement and in the back of this presentation. Slide 10 once again illustrates the progress we've made in reducing our senior debt since the transaction in 2019. Reflected in the presentations are total debt position at the quarter's end. We've continued our practice of using operating cash to pay down senior debt. And as of today, we've paid down $19 million of senior debt, an additional $4 million since the end of the quarter and $19 million since the S3 acquisition in June of 2019. Our second quarter cash generation was impacted by the integration of the financial systems, but since that's complete, our outstanding receivable backlog has decreased with strong collections in April and early May, which is a great start to Q3 from a cash flow standpoint. Looking forward, we anticipate a debt balance of between $42 million and $45 million at fiscal year-end. Prepaying our debt not only strengthens the company's financial position, of course, it reduces our interest expense, improving our bottom line results. As Zach mentioned previously, we are well in - we are - as of today, no further debt repayments required until September of 2022. This concludes my discussion of financial statements. With that, I would now like to turn the call over to our operator to open the call for questions.

[Operator Instructions] Our first question today will come from Ken Herbert with Canaccord.

I hope everybody is well with - in these challenging times. I just wanted to first ask, historically, Kathryn, you've seen a nice step-up in gross margins from the first half to the second half of the fiscal year. I'm wondering with the different mix now in S3, how should we think about gross margins into the third and fourth quarter?

Yes. I think we will be pretty consistent with the second quarter and maybe slightly better. We are, of course, as you mentioned, going to see stronger contribution from the VA program as that - as the volume has increased there, which while it grows, our absolute gross margin is one of the lower gross margin rate parts of the business. On the other hand, we do think that the contributions from the business acquired will continue to grow as we expand on the contracts that Zach discussed in his comments. So we are continuing to plan towards a 21% to 23% gross margin. We delivered 21.6% this quarter. And I think for planning purposes, I'm looking at around something similar to that to around 22% for the year - or for the remaining quarters of the year.

Okay. That's helpful. Yes, and great news on the CMOP there and the change in contract structure. Is it - two questions around that. First, when do you expect a sort of a formal recompete process under sort of the revised structure? And then second, as you think about your other VA work, I know there's been some debate as to whether the other contract streams would follow the proposed CMOP structure. But now they've backed away from that, do you expect - you don't expect any changes in the other streams, I would imagine, as a risk of a set-aside?

Sure. Yes. We are - let's start with your second question with regard to what's in the pipeline. We've been really very actively focused on that work, which is not - which we believe is not subject to set-aside. There are certain opportunities, of course, where we're going to lean in on a couple of set-aside projects where they - where it makes sense for us strategically to bolt on additional capabilities. So it will continue to be a part of our new business pipeline. Every indication is that we see really strong prime opportunities in the future for DLH. And again, also an opportunity, too, for some set-aside work, too. With regard to the schedule on the new solicitation or revised solicitation, it's still difficult to tell. It's really too early to tell. There have been some changes, of course, in some of their some of their organization. And they're looking at the - what to do with the new solicitation. Quite frankly, like many other acquisition shops, they're pretty much all hands on deck for things associated with COVID-19 to support our veterans. So we suspect that with what's going on in the pandemic, it will probably slide things to the right a bit. So we're seeing no impact through the course of the remainder of this fiscal year. And best estimates, we'd probably say we would continue through a fair amount of next fiscal year as well.

That's great. And just finally, if I could. In light of obviously everything with COVID-19, you've clearly got a very well-positioned portfolio now with the addition of S3. Can you provide any metrics around maybe quote activity or pipeline opportunities that you're seeing in light of the pandemic? And I know - I can appreciate it's still early and there's just a lot going on in many different directions. But anything you can comment on just the bid and activity levels in response without thinking about firm business maybe. But how are you seeing this opportunity evolve?

Sure. So there's a couple of ways in which we've been engaged. First and foremost, whenever there's something that's this time-sensitive, quite often, they require companies like ourselves to pivot our resources from existing tasking areas to devote our resources on the currently. A substantial amount of the work we have done has been in that vein, right? So we'll have folks under the direction of our Chief Scientist and others really reallocate some of our epidemiologists and how we purpose our clinical trials and labs and things of that nature. So that's been the first part of it, right, so that they don't have to wait through an acquisition cycle. At the same time, we've had - I want to say in the order of about a dozen bids, right? These bids are for - largely for the Center for Disease Control and NIH. There are some that may be coming also from some other countries looking at support that we're entertaining as well. But as you might imagine, some of these are small turnkey quick turns, right? And we've won a couple already. And there'll be relatively turnkey opportunities. And then as things start to stabilize and we start to get a handle around the type of therapeutics and the type of vaccines that may start to mature, that's when the government can then start to take a look at what's going to be our approach to outreach and what's going to be our additional approach to now gather data and information from those trials and studies, and move into Phase IIs and IIIs. So it will continue, as we've seen, for previous epidemics and pandemics, it will continue to evolve with some short-term, quick-turn items and then level-set into more sustainable activities later. So we'll know more over the course of this next quarter with regard to the quick turns and then we'll, of course, be able to talk a little bit more about what the future looks like. This is clearly - as this kind of work goes, this is clearly a virus that's going to go away completely anytime soon. We've continued to be doing work on other legacy viruses, including, as you know, HIV and others, as well as the impacts that they have on chronic diseases, as we described in our presentation, and then protection for certain populations, such as our veterans and those most vulnerable. I think there's going to continue to be some studies around the most vulnerable. And of course, in this case, it's not only our seniors but for those in underserved areas in the country, and particularly, in the minority community. And so there will be a number of, we think, spin-ons that once we get through this initial phase, we'll be pretty well positioned to support going further.

[Operator Instructions] Our next question will come from Chris Bliska of NOBLE Capital.

Congratulations on a great quarter. I have two questions. VA revenues, up 12.6% year-over-year. Can you give a little granularity on what drove that and the sustainability of that increase, please?

We think it is sustainable. There's a couple of things in play right now. One is there has been just standard organic increases in demand and support for the VA from a pharmaceutical standpoint. In addition, as Kathryn alluded to a little bit, late in the quarter, in March, we started to see some impact relative to COVID-19 as well. It is a challenging work environment. So there's some volatility across our workforce to make sure we can see those demands. But we do think it's indicative of what's going to be sustainable for some time to come, certainly over the next several quarters. So again, you just got a piece of it in Q2, but we do expect to see continued expansion in the upcoming quarters as well. We'll get an idea about where that plateau is. We'll have a better idea, I think, by the time we get to the end of this fiscal year. But we clearly see it's in a growth mode overall. Kathryn, anything to add to that?

I think that's exactly right. There are some things that - obviously, the effect of COVID are pervasive. And so one of the knock-on effects of that for the VA is that they're obviously trying to socially distance within their medical treatment facilities and military treatment hospitals. And so they're steering work that otherwise they would have fulfilled there inside the hospitals having it route through CMOP. So there's a natural gauge in transition of work over to the VA facility - over to the CMOP to fulfill on behalf of VA. And as we mentioned earlier, I don't see those practices of trying to minimize traffic through those facilities curtailing anytime very soon. So we expect that to be sustainable, not to mention of which I think it's a very cost-effective way to managing the business. So I think once that traffic is steered that way, we expect it will sustain.

And then just - I think you touched on this in response to an earlier question. But specific to S3, the revenue increase of $1.4 million, I think you had said previously that you thought you'd see some impact from COVID. So is it - is any of the $1.4 million increase specific to new work relative to the virus?

No. No. It's really - that's really related to the timing of some particular studies that we already had in play before the occurrence of the COVID transaction. So as Zach mentioned - and it's very not - it's very traditional and very, very expected that, right now, the COVID support is really triage work. It's a pivot of current resources on current contracts to really focus on a priority basis on COVID support. The sustainable incremental efforts from COVID will come a little bit in small pinpoint kind of activities in the balance of this fiscal year, but the long-term longitudinal analysis of the impact of COVID on other long-term chronic diseases and those sort of studies, projects that would have to be completed, that we're probably 18 to 24 months away from that because, naturally, our government customers are prioritizing the triage response right now.

Our next question will come from [Gary Heffernan of Walterstein].

Zach, Kathryn, your performance has been admirable. And thank you very much for all the hard work that you and the employees have done here.

Very well. Thank you.

Thanks for your support.

I guess this - I guess, perhaps, best towards Kathryn. I'm interested to understand the - your position, your philosophy towards debt and cash. Certainly paying down the debt at the rapid rate that you have and providing yourself some cushion as to when the next principal payment is due is comforting. But then there's also the question where many management teams right now are allowing cash to build on their balance sheet if possible as opposed to making early debt payments because cash in hand is better than cash at the bank with a promise. So can you give us your thoughts as to how you're approaching that to - per your statement here of expecting the projected year-end debt balance down to $42 million, $45 million versus leaving it at the $55 million level and just accumulating a cash balance on the balance sheet of that differential?

Sure. Thanks for the question, Gary. We do have available to us to - first of all, we generate strong operating cash flow, so I expect that to really sustain my operating needs going forward. I don't expect to be in a net borrowing mode. But if I did have a gross required need for cash, I've got access to a revolver that I can dip into. It's a $25 million revolver. I think I've needed it maybe 3x as we've gone through the transition and consolidation of our financial system. And it's currently sitting at a 0 balance. So I've got a lot of capacity there for borrowing, and I've got a committed credit agreement with a lending group that provides the formula for borrowing under that. So I don't feel particularly compelled to accumulate cash, but - because I think I have ready access to cash needed to fund operations if operating cash flow for whatever reason is not sufficient because of the growth rate. So I do - I have heard that view. I definitely have heard people talk about borrow - hoarding cash and even drawing down on lines of credit and borrowing my whole revolver. All those things are available as strategies to us. But I think we have a - given now the visibility we have into the durability of our revenue and the demand for our services and the customer requirements, I feel we are able to responsibly continue supporting debt reduction even as we manage operations through this challenging time.

And Gary, I would echo your, I think, observation that in a lot of my peer - our peer companies, a lot of my peer leaders, are certainly looking at the pros and cons given today's environment. Particularly unique to this environment right now, several of our peer companies are actually looking at having to deal with the 3610 requirements under - the federal government has just issued to try to provide additional protections during periods where many of our companies are really, really struggling. Our peer companies are really, really struggling, where they don't have the ability to still continue to provide services to the client. We are considered an essential organization under these areas and not everyone does. So in conditions like this - anticipating conditions like this, it would have been great for those kind of companies to have taken a different position, right, as you've described, relative to cash, creating a larger cash stat position. But as Kathryn indicated, we've got a couple of hedges already in place for that. We do have designs on continuing to organically and acquisitively look at things over the course of the next year or 2 strategically. And we think there's a good balance for us right now with very minimum risk associated with our cash position.

In regards to the $25 million revolver, which has a 0 draw on it currently, could you just give us an idea of what banks that is established through and what the maturity date on that revolver is?

Yes. It's actually linked with my term credit through the banking consortium led by First National Bank that supported our S3 acquisition. So as part of securing that new financing, we committed to some term debt as well as a revolver to complement that, and they both have a maturity date in June of '24.

We have no more questions in queue at this time, and this will conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Parker for any closing remarks.

Thank you. And just to everyone on the call, we really, again, appreciate all of your support, continued support and interest in the company. As you may be aware, I think last time we chatted, we had introduced a couple of investor conferences that were right around the block. As is consistent with our company experience, we are moving to - we are operating in a very highly telecommuting mode and of course, encouraging all of our employees to continue to respect the social distancing guidance from across the country. As such, 1 or 2 of those investor conferences have been canceled, one canceled and the other is deferred. So we'll continue to give you - to keep you posted on the updates on those. We do look for an opportunity to really add some of the depth and color around the business. If it looks like they're going to go be deferred outside - too much outside of this fiscal year, we may very well do a stand up - stand up a town hall, road show kind of conference ourselves just to give you additional color around the kind of questions you've had today and then what we're going to see in the maturity of that pipeline in the relative near term. So stay tuned. And again, we thank you for your support. Stay safe, be blessed and we'll talk soon. Bye for now.

The conference has now concluded. Thank you very much for attending today's presentation. You may now disconnect.